Query No. 21

 

Subject:           

Recognition of revenue arising from ground rent. 1

 

  A. Facts  of  the  Case

 

1. A government  company,  within  the  meaning  of section  617  of  the Companies Act, 1956, is working under the administrative control of theMinistry of Railways (MoR), Government of India.  In respect of the affairs of the company, the principal decisions are taken by the MoR. These decisions are implemented by the board of directors of the company after necessary deliberations and passing necessary resolutions in respect of such decisions.

 

2. The company is engaged in the business of handling and transportation of containerised cargo. The containers are transported by road, rail and air. The company provides these services to shipping lines, clearing and forwarding agents and other customers. The company operates container terminals across the country to cater to the needs of the trade which includes export-import business as well as domestic business. Accordingly, the activities of the company have been divided into International Traffic (export and import business) and Domestic Traffic (domestic business). The operating activities of the company are mainly carried out at its Inland Container Depots (ICDs), Container  Freight  Stations  (CFSs)  and  Port  Side  Container  Terminals (PSCTs) spread all over the country.

 

3. The main sources of income of the company are from freight, handling charges, transportation charges, ground rent and wharfage, etc.  The querist has provided the following brief description of these incomes:

 

        (a)        Freight and transportation incomes are the rail and road haulage charges respectively, charged from the customers.

 

        (b)        The income from handling is the amount received for handling of the containers.

 

        (c)        Ground rent is the parking charges for the time period during which a container remains parked in an ICD of the company                     after the expiry of permissible free time limit. The income also includes charges for safety and security of containers/cargo.

 

        (d)        Wharfage is the amount collected for cargo which remains in the warehouse beyond its permissible free time limit.

 

Major expenditure of the company is towards freight payment to Railways and  payments  made  to  contractors  for  handling  and  transportation  of containers.

 

4. The  company  has  adopted  the  following  accounting  policies  for recognition of revenue/expenses during the financial year 2000-01:

 

Policy  no.  1  in  Schedule  10:  Accounting  conventions  & concepts

 

“The financial statements are prepared under the historical cost convention generally on accrual basis and in accordance with applicable mandatory accounting standards and relevant presentational requirements of the Companies Act, 1956. Accounting policies not referred to otherwise are consistent with generally accepted accounting principles.”

  

Policy  no.  11  in  Schedule  10:  Terminal  and  other  service  charges

 

“Freight and handling income/expenses are accounted for at the ti me of booking of containers. Ground rent and wharfage are accounted for at the time of release of containers on ‘completed service contract method’. Claims/penalties are accounted for at the time of settlement.”

 

5. Comptroller  and  Auditor  General  of  India  (C&AG)  while  issuing comments under section 619(4) of the Companies Act, 1956, on the accounts of the company for the financial year ended on 31st  March, 2001, issued a half-margin on revenue recognition by the company which stated as below:

 

“Terminal and other service charges of Rs. 1,07,479.75 lakh on the income side in the profit and loss account include a net income of Rs. 6,911.76 lakh towards ground rent after deducting ground rent waived/ discounts given to various parties amounting to Rs. 336.53 lakh. Thus, the company had not only contravened the statutory requirements laid down in Part II of Schedule VI to the Companies Act, 1956, but had also understated the income as well as expenditure to the extent of Rs.

336.53 lakh.”

 

6. The management of the company had given the following reply to the half-margin issued by the C&AG:

 

“The Accounting Standard (AS) 9, ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, provides for two methods of recognising revenues from services – (i) Proportionate completi on method and, (ii) Completed service contract method. In the secon d method, revenue is recognised in the statement of profit and loss only when the rendering of service under a contract is completed or is substantially completed. In line with the requirements of AS 9, the company has adopted accounting policy no. 11 pertaining to terminal and other service charges which provides that the accounting for ground rent is done at the time of release of containers on completed service contract method”.

 

7. According to the querist, the company has been giving waiver of ground rent to its customers on the basis of commercial considerations. In some of the cases, waiver is granted before the billing is done to the party. According to accounting policy no. 11 on ‘Terminal and other service charges’ of the company, ground rent is accounted for at the time of release of containers on ‘completed  service  contract  method’.  Since  the  amount  of  ground  rent expected to be realised is ascertained at the time of release of containers, customer is billed with the amount realisable on account of ground rent. The money so realised is credited to the concerned income head. As per the querist, such an accounting procedure is clearly justifiable in terms of provisions laid  down  in  clause  9.1  of  AS  9  which  states  that  revenue  should  be measurable and that at the time of sale or rendering of the service it should not be unreasonable to expect ultimate collection. Therefore, income from ground rent is shown in the statement of profit and loss at the amount ultimately realisable from the customer.

 

8. As per the querist, accounting for waiver granted to the customers has been a matter of discussion several times and as stated above, the government auditors have also raised this matter during the audit for the financial year 2000-01.  An  assurance  was  given  to  the  government  auditors  that  the treatment of waiver would be reviewed during the current year. Accordingly, the company has decided to seek opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India in this matter.

 

B. Query

 

9. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting policy being followed by the company with regard to accounting for ground rent, as detailed in paragraph 7 above, is in compliance with the provisions of the Companies Act, 1956, and AS 9.

 

C. Points  considered  by  the  Committee

 

10. The Committee notes that the querist has sought the opinion of the Committee only in respect of recognition of revenue arising from ground rent. Accordingly, the Committee has not considered any other issues that may be contained in the facts of the case such as recognition of revenue arising from sources other than ground rent.

 

11. The Committee notes from the facts of the case that ground rent is the parking charges for the period during which a container remains parked in an ICD of the company after the expiry of the permissible free time limit. The revenue also includes charges for safety and security of containers/ cargo.

 

12. The Committee notes that the provisions of AS 9 are based on the accrual basis of accounting as required under section 209 of the Companies Act, 1956.  This fact is recognised in the ‘Guidance Note on Accrual Basis of Accounting’, issued by the Institute of Chartered Accountants of India, paragraph 8.1 of which, inter alia, states as below:  

“The Council of the ICAI and its various committees have issued various Guidance Notes, Statements and Accounting Standards. The accounting treatments contained in these documents are primarily based on accrual accounting. Thus, adoption of accounting treatments recommended in these documents would ensure that a company has followed accrual basis of accounting.  ...”

 

13. The Committee notes paragraphs 7.1(ii) and 12 of AS 9 explaining the completed service contract method as follows:  

“7.1(ii) Completed service contract method – Performance consists of the execution of a single act. Alternatively, services are performed in more than a single act, and the services yet to be performed are so significant in relation to the transaction taken as a whole that performance cannot be deemed to have been completed until the execution of those acts. The completed service contract method is relevant to these patterns of performance and accordingly revenue is recognised when the sole or final act takes place and the service becomes chargeable.” 

“ 1 2 .   In  a  trans action  involving  the  rendering  of  services , performance  should  be  measured  either  under  the  completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service.”

 

14. The Committee notes that the company renders the service of handling and transportation of containerised cargo.  The Committee is of the view that apparently parking of containers is only one of the acts to be performed in the rendering of the service.  The Committee presumes that the containers in respect of which ground rent is charged are the containers which reach the destination and remain parked over and above the permissible free time limit. The Committee is of the view that in the context of the overall rendering of services, services yet to be performed are not so significant in relation to the transaction taken  as  a  whole that  performance  cannot  be  deemed  to have been completed until the actual release of the containers. The Committee is, therefore, of the view that the company should not consider completion of the service on actual release of the containers.  The Committee is also of the view that in respect of the ground rent which is not collected on the balance sheet  date  the  principles  enunciated  in  AS  9  related  to  the  effect  of uncertainties on revenue recognition should be applied.

 

15. The Committee notes paragraphs 9.1 to 9.3 of AS 9 which provide as below:

 

“9.1  Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection. 

9.2  Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest etc., revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. Where there is no uncertainty as to ultimate collection, revenue is recognised at the time of sale or rendering of service even though payments are made by instalments. 

9.3  When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded.”

 

16. The Committee notes from the facts of the case that the company has been crediting the income from ground rent on release of containers. The Committee is of the view that revenue from ground rent should be recognised on straight line basis over the period during which a container remains parked in an ICD of the company after the expiry of the permissible free time limit provided no significant uncertainty as to its measurability or collectability exists. In case a significant uncertainty as to its ultimate collection exists, revenue recognition should be postponed to the extent of uncertainty involved. Thus,  the  accounting  policy  being followed  by  the  company  would  be appropriate only if significant uncertainty about the ultimate collection of ground rent exists in all the cases, and the amount of ground rent income becomes measurable and its ultimate collection becomes certain only on release of containers.

 

17. The Committee is of the view that the mere fact that the ground rent is not charged, in certain cases, from the customers on commercial considerations after the balance sheet date does not by itself justify crediting the entire amount of such ground rent as income only when the containers are released. The Committee is of the view that on the balance sheet date, in respect of the containers which remain parked in an ICD after the expiry of the permissible free time limit, revenue should be recognised for the time lapsed from the date on which the permissible free time limit expires and the balance sheet date  unless  there  is  significant  uncertainty  about  the  collectability  or measurability.   For this purpose, events occurring after the balance sheet date but before the finalisation of the accounts may also be considered.

 

D. Opinion

 

18. On the basis of the above, the Committee is of the opinion that the accounting policy followed by the company with regard to ground rent is not in compliance with the provisions of the Companies Act, 1956, and AS 9. The revenue from ground rent should be recognised on straight line basis over the period during which a container remains parked in an ICD of the company after the expiry of the permissible free time limit provided no significant uncertainty as to its measurability or collectability exists.

 

 

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